A Smart and Principled Plan to End 'Too Big to Fail'

The CEO and Research Director of the Federal Reserve Bank of Dallas have written a clear, smart, and principled proposal for reforming our banking system, and for managing the moral and financial crises our too-big-to-fail banks have caused and perpetrated. The plan proposed by Richard Fisher and Harvey Rosenblum is clear, because it follows a simple three-point structure; smart, because it provides a comprehensive framework for reform; and principled, because it restores several fundamental principles to our banking system, include the "free-market" principle which conservatives claim (often falsely) to hold so dear.

Their analysis of the problem is right on target: "A dozen megabanks today control almost 70% of the assets in the U.S. banking industry," write Fisher and Rosenblum, who go on to say that:

"...(T)he mere 0.2% of banks deemed "too big to fail" are treated differently from the other 99.8%, and differently from other businesses. Implicit government policy has made these institutions exempt from the normal processes of bankruptcy and creative destruction. Without fear of failure, these banks and their counterparties can take excessive risks."

As Attorney General Eric Holder made clear last week, they can also feloniously launder money for the drug cartels if they so choose, secure in the knowledge that the law won't touch them.

These banking behemoths continued to perform better than they should in the stock market, despite their record of fiscal mismanagement, executive errors, and institutional mendacity. Jamie Dimon, CEO of JPMorgan Chase, misled investors about the scope of the "London Whale" scandal, which lost billions for the bank after Dimon boasted of a superior risk management model which was ignored by the London unit (which reported to Dimon directly).

And yet JPMorgan Chase suffered no deep and lasting damage from these or other revelations. Grossly mismanaged institutions like Citigroup and Bank of America seem equally immune for their own flaws. Why? Because investors assume that these banks will be rescued, no matter how grossly mismanaged they may be, and their expectations are well-grounded in the experience of the last four years.

As Fisher and Rosenblum note, studies have shown that this expectation of government rescue is worth "as much as one percentage point, or some $50 billion to $100 billion annually, in the period surrounding the financial crisis."

Think of it as yet one more taxpayer bailout.

As the authors note, the Dodd/Frank bill doesn't address the fundamental and systemic problem this poses. Instead it tried to balance the public interest and those of mega-bank executives and became excessively complicated as a result. In places this has turned it into a Rube Goldberg-like contraption of regulatory complexity. The answer isn't to jettison banking regulation. The answer is smart, simple reform.

That's where Fisher and Rosenblum come in. First they would restrict government support - deposit insurance and the Fed's discount window - to traditional commercial banks. Remember them? They're the ones who lend money to people, and to businesses that hire people and sell goods and services to people. Principle No. 1 is therefore: Government banking assistance should go to bankers - not speculators, gamblers, or hedgers.

Next, say the authors, "customers, creditors and counterparties of all nonbank affiliates and the parent holding companies would sign a simple, legally binding, unambiguous disclosure acknowledging and accepting that there is no government guarantee--ever--backstopping their investment."

No more free rides for investors at government expense. Let the market decide how much it values Dimon's JPMorgan Chase, or Brian Moynihan's Bank of America, or the country's other cumbersome creations. The principle? Free-market capitalism.

Lastly, the too-big-to-fail banks would "be restructured so that every one of their corporate entities is subject to a speedy bankruptcy process, and in the case of banking entities themselves, that they be of a size that is 'too small to save.'" As Alan Greenspan said (before it became clear there would be no penalty for grossly misreading the economy), "Too big to fail is too big to exist."

Will the Fisher/Rosenblum plan work? Our financial system's too complex to give that question a facile answer. But while the details might need to be fine-tuned, overall the answer is "yes." Their proposal outlines the continued urgency and gravity of our banking system's systemic flaws, and provides a framework for reform that should alter our national debate.

Will it alter that debate? Wall Street money and influence suffuses both our politics and our media, so the answer to that question remains to be seen. But the ideas presented by Fisher and Rosenblum should reshape our national conversation over the financial and moral failure of our current banking system.